I know I promised to give UR readers a break this week, but the ongoing degringolade of our financial system is just too exciting to ignore.

This post is about the mechanics of returning to what people used to call hard money. This is a very difficult problem for which there is no good solution. However, as we'll see, some solutions are worse than others. If you need a celebrity endorsement, or quasi-endorsement, Brad Setser says: "if nothing else, your plan is creative." Indeed.

I will not be discussing the question of why the gold standard should be restored. I assume you either believe this is a good idea, or you don't. If you don't, perhaps you don't care. (Perhaps you haven't looked at the news lately?) Please feel free to come back next week.

First, let's face it: the dollar is about as far from being "as good as gold" as Hillary Clinton is from being "a major-league hottie." She needs a lot of work, and I mean a lot. Restoring the gold standard is about as easy as restoring a '57 Chevy that has been in the same barn since '68. Assuming of course that the world has been taken over by zombies, and your only tools are a chainsaw, a hammer, and a case of cheap brandy.

On the other hand, just pushing the Chevy down the road into zombie land isn't going to work too well, either. So why not at least think about trying it? And that, I promise, is the last I will say on the subject. At least for now.

First: there is a simple plan for successfully restoring the gold standard, which any sovereign can apply at any time for any reason, and which will always succeed.

Let's call it "Plan X." To restore the gold standard via Plan X, you need exactly two facts: the face value of valid fiat currency you have outstanding, and the grams of gold in your treasury. (If you do not have this information, you are beyond the reach of accounting. Your country is probably about to be overrun by savage tribes. You should be looking for a seaworthy vessel, not trying to fix your monetary system.)

Let's call the first quantity F and the second quantity G. The new gold price, Pnew, the price of a gram of gold, in cowries or strips of leather or wood chips or whatever your people are putting out these days, is F/G. At least, it is at least F/G. At your discretion, Sublime Pasha, it may be greater. I don't think I have to point out the advantages of this option.

What makes a Plan X restoration slightly tricky is that whatever Pnew is, there is also a Pold - the present price of a gram of gold. Since Pnew has to exceed Pold or no one can possibly care, and since it offends the Pasha's dignity for the Armenians to front-run his ass down in the bazaar, Plan X depends on the element of surprise. While it shares this with all monetary policy, the amount of loot a leak can extract in a Plan X gold restoration is effectively infinite and untraceable. Problem.

Thus it is very difficult for an inefficient bureaucratic state, which is indiscreet by definition, to even consider Plan X as a viable policy option. Since an efficiently managed state would never have left the gold standard in the first place, this problem is unsolvable. Moreover, the same problem holds for all feasible restoration plans. The option of just letting Pnew equal Pold is not physically tractable without some serious alien technology. There is not enough gold on Planet Three. You would need to go in for asteroid mining, or something.

Since this problem is not solvable, we will ignore it. Often people are faced with multiple contradictory problems. I'll bet a lot of them are working 100-hour weeks right now. To even start to deal with a situation like the present financial crisis, you have to at least know why all your impossible courses of action are just as impossible as they seem.

But there is a second problem with Plan X, which is that it is not politically feasible. Ie, if you just apply Plan X, it will leave a very large number of people hatin' life, and hating you as well. This is not conducive to a successful career in public service. And this is why, I think, people shrink so instinctively from the very thought of restoring the gold standard. They associate it with Plan X, which is too hateful even to mention. In fact, while moral judgments are not my specialty, I don't think it's going too far to describe Plan X as outright unethical.

Here is the problem with Plan X.

The monetary base of the United States today - the number of dollars outstanding in the strict legal sense of the word dollar - is about $800 billion. The monetary base is physical currency, plus the balances of member banks at the Fed. (In case you are unfamiliar with the actual structure of the Fed, think of it as a secret uber-bank at which only banks have bank accounts.)

US gold reserves are about 8000 metric tons. Ergo, F/G is about $100 million per metric ton, or $100K per kilogram, or $100 per gram. Since gold today is around $30 a gram, this represents a Pnew/Pold ratio of about 3. (Obviously, all these values are constantly changing.)

So Plan X, if applied to the dollar, would triple the gold price overnight. This seems rather extreme. It suggests that Pnew is way too high. Perhaps, but it's also way too low. Did I say this would be easy? If restoring the gold standard was easy, someone would have done it already.

The problem is that the monetary base (M0, or F above) is not a particularly important or useful number. It is not in fact a good representation of "the number of dollars in the world." This is well-known. And there are a variety of other monetary indicators, with snappy little numbers attached, like M1, M2, etc. In Britain they even have M4, which I was sure was a motorway. In any case, none of these numbers is of much interest either. They are all the result of subjective decisions, littered with constants pulled out of thin air, etc, etc. This again is quite well known. No one has done anything about it, because no one can do anything about it.

(The idea that monetary policy can be managed by mathematical models is, in fact, madness. The experiment is neither deductively understood nor scientifically controlled. Fitting models to the past is no substitute: it will always produce a "data mining" effect. If one of these models somehow turned out to be correct, you would have no way of knowing which one it was.)

Why is it impossible to measure the quantity of dollars in the world? Especially in a modern country which is not about to be overrun by savage tribes, and really does keep a handle on its monetary base? A fascinating question, folks.

We can start to see the answer by looking, within the monetary base, at the difference between electronic dollars at the Fed and actual physical bills. These objects could not be more different - one is a magnetic mark on a hard disk, the other is a piece of paper. Why do we lump them together and treat them as the same thing?

They are equivalent because either form is convertible to the other. Any bank can take a bundle of bills to the Fed and exchange it for electronic credits. Any bank can also draw down its electronic balance in the form of print jobs. Both these rights are protected by law, and there is no conceivable scenario on which the Fed runs out of either disk space or paper.

You'll sometimes hear dollars in the monetary base called "high-powered," an incredibly weird and confusing locution. Let's just call them formal dollars. Since these dollars are all valid at present, they are formal current dollars.

The reason it's impossible to measure the quantity of dollars in the world is that a formal current dollar is only one point in a vector space. Formality and maturity are both variables. Worse, the latter is quantifiable but the former is not. So we are trying to describe an unquantifiable two-dimensional vector as a precise scalar (our F). If this isn't mathematical malpractice, I don't know what is.

How do we solve this problem? As usual, by trying to understand it.

Let's deal with maturity first. Imagine that every dollar bill had a "not valid before" date on it, like a postdated check. Maturity is simply the difference between now and that time. For example, a zero-coupon Treasury bond which matures in 10 years could be defined as a dollar bill which is not valid until 2018. We can call these dollars not current but latent.

Formality is the extent to which an instrument is guaranteed, in practice, by the Fed. A Federal Reserve Note ("dollar bill") is perfectly formal. A piece of paper which says "Mencius Moldbug promises to pay the bearer one (1) dollar" is perfectly informal. Between these lies a wide range, which cannot be measured or quantified, but is no less important for that.

A Treasury bond is almost perfectly formal - but not quite, since the Fed and Treasury are at least in different buildings. In practice, the financial markets treat Treasury obligations as perfectly formal or "risk-free." It is probably best to describe them as negligibly informal.

"Agency" bonds - those written not by Treasury, but nominally private companies (GSEs) such as the infamous Fannie and Freddie - are mildly, but not negligibly, informal. The bond market puts a small premium on agency bonds over T-bonds (typically a quarter point or so), showing that they have a small chance of defaulting. This is essentially a political calculation, and financial markets do not hesitate before making political guesses - which is not to say that they are always right. (Note that we cannot use the GSE spreads as quantifications of formality, because there is another variable in the equation - the actual default risk.)

But the most famous kind of informal dollars are the negligibly-informal current dollars we call "checking deposits." While checking accounts are not as financially important as they once were, most people have one and most everyone understands them.

A checking deposit is actually a loan from you to your bank. This loan has a zero maturity and is continuously rolled over. If you find this hard to grasp, imagine the loan term was one minute. Every minute, the bank automatically returns your money to you, and you automatically lend it back to the bank. If you show up at the ATM and want to withdraw it, you have to wait until the minute is over. Replace a minute with zero, and you have the "demand deposit."

It would sort of defeat the purpose, but imagine that your checking-account dollars were not electronic entries, but physical bills. They look just like regular dollar bills, except that they are blue, not green, and they have your bank's name instead of the Fed's - eg, "Wells Fargo Note."

A dollar in a checking account is informal because it is a debt, and the debtor is not the mighty Fed but a sordid, corporate bank. The Fed will not just take a blue dollar and convert it to a green dollar. Your bank has to do that, and your bank has to have its own green dollar to exchange for your blue dollar. If it's out, the Fed will not just give it more.

However, like the Treasury bonds, blue dollars are negligibly informal. Your bank is "insured" by something called the FDIC. This so-called "deposit insurance" is in fact a sham, because the risk of a bank run is not in any way, shape or form an insurable risk. Nor does the FDIC have anywhere near enough green dollars to exchange for all the blue ones. However, although the Fed is not legally obligated to back up the FDIC - just as it is not legally obligated to back up the Treasury - it is a political certainty that it will do so.

We can think of informal instruments, like agency bonds or blue dollars, as an inseparable combination of two instruments: a private debt (eg, your bank's debt to you, as represented by the blue dollar), and an option written by the Fed. The option pays off if the debt does not - unless, of course, the Fed's informal loan guarantee turns out to be not just informal, but actually nonexistent.

We are now in a position to understand the horrendous destruction that Plan X would unleash upon society. Since Plan X does not recognize the existence of informal dollars, applying it is equivalent to destroying them, or more precisely destroying their informal Fed option halves. The debt from the bank to you still exists. But will it be paid? Um...

Plan X is easier if we think of it in two phases. In the first phase, we destroy the informal options and set F to the monetary base M0. In the second phase, we exchange every formal current dollar for F/G grams of gold, courtesy of Fort Knox. (There are no formal latent dollars - the Fed issues no such thing.) After we perform the first phase, we can perform the second at any time, so we can analyze them separately.

All the destruction in Plan X comes from the first phase. Call it Plan X(1). Another way to think of Plan X(1) is that (after printing the entire monetary base), we destroy the Fed's printing press. No new dollars can be created, ever. If this reminds you of the breaking of the assignat plates, you're not alone:

This system in finance was accompanied by a system in politics no less startling, and each system tended to aggravate the other. The wild radicals, having sent to the guillotine first all the Royalists and next all the leading Republicans they could entrap, the various factions began sending each other to the same destination: Hébertists, Dantonists, with various other factions and groups, and, finally, the Robespierrists, followed each other in rapid succession. After these declaimers and phrase-mongers had thus disappeared there came to power, in October, 1795, a new government, - mainly a survival of the more scoundrelly, - the Directory. It found the country utterly impoverished and its only resource at first was to print more paper and to issue even while wet from the press. These new issues were made at last by the two great committees, with or without warrant of law, and in greater sums than ever. Complaints were made that the army of engravers and printers at the mint could not meet the demand for assignats - that they could produce only from sixty to seventy millions per day and that the government was spending daily from eighty to ninety millions. Four thousand millions of francs were issued during one month, a little later three thousand millions, a little later four thousand millions, until there had been put forth over thirty-five thousand millions. The purchasing power of this paper having now become almost nothing, it was decreed, on the 22nd of December, 1795, that the whole amount issued should be limited to forty thousand millions, including all that had previously been put forth and that when this had been done the copper plates should be broken. Even in spite of this, additional issues were made amounting to about ten thousand millions. But on the 18th of February, 1796, at nine o'clock in the morning, in the presence of a great crowd, the machinery, plates and paper for printing assignats were brought to the Place Vendome and there, on the spot where the Napoleon Column now stands, these were solemnly broken and burned.

Well, it certainly sounds like the right move at the right time. And who can't resist the idea of sending a few phrase-mongers, not to mention Republicans, to the guillotine?

But the good news is that we are not in a state of revolutionary hyperinflation. At least, not yet. The bad news is that the result of Plan X(1) would be an episode of economic destruction that would make the Great Depression look like a panty raid.

The informal loan guarantees we destroyed may have been informal. But they existed. And people relied on them - just as if they were formal.

For example, by breaking the plates, we eliminated the Fed's informal guarantee of Treasury debt. Surprise! Over the next 30 years, Treasury is now obligated to fork over ten times as much gold as now exists in the United States - since the Treasury's debt is about ten times the monetary base.

What do you think is the chance that this will actually happen? Fairly small, I would say. I suspect long-term interest rates, at least as measured by Treasury bonds (which is how they're measured now) would go from about 5% to more like 50%. If not 500%. The good news is that you could actually buy that house you've been saving for.

The bad news is that your savings probably won't be there. Because they are probably in blue dollars, or something like them. Those debts from various financial entities to you still exist. But the various financial entities don't. They will instantly face the mother of all bank runs as people with blue dollars rush to exchange them for green.

The Fed's loan guarantees, it turns out, have been serving an essential structural purpose in our economy. They have been making term transformation stable. The interaction between term transformation and fiat loan guarantees deserves its own Nitropian analogy, but what we do know is that term transformation is not stable without them. Ergo, since it is not stable, it will collapse. The good news is that you might be able to buy a hamburger for ten cents again. The bad news is that you might not have ten cents.

So our definition of F as the monetary base has a great flaw, which is that it does not account for the informal loan guarantees, which are legally meaningless but economically important. As a result, we are simply destroying a large quantity of money - the monetary equivalent of filling your gas tank with molasses. Woops.

There is only one way fix this. Our new plan, Plan Y, has to include informally guaranteed instruments as well. Furthermore, because it includes informal instruments, it has to deal not just with current dollars but with latent dollars (such as Treasury bonds).

How does Plan Y deal with informal dollars? Very simply. It creates formal dollars, and exchanges them for the informal dollars. So, for example, the Fed can buy all the checking deposits that it has guaranteed. Your checking account becomes a green-dollar account at the Fed. The debt from your bank to you is now a debt from your bank to the Fed.

Alternatively, the Fed could just buy your bank at the present market value - ie, nationalize it. This is less financially elegant, but it may be simpler in practice. It also has another advantage, which is that it wraps up the maturity mismatch on the bank's books. Your bank is almost certainly backing its short-term obligations with long-term receivables. If the Fed refuses to renew the rolling loans that used to be everyone's checking deposits, the banks will fail. If it lets them roll on for ever, it might as well cancel them. Either way the result is ugly.

There are two ways for Plan Y to deal with latent informal dollars. One is to exchange them for latent formal dollars. The other is to exchange them for current formal dollars.

Perhaps the former could be made to work, but the latter is probably superior. The trouble is that in a world with protected term transformation, we really have no idea what the maturity preferences of investors are. If we assume that they correspond to their current holdings, we run the risk of considerable economic disruption.

The people who have been buying 30-year T-bonds are not, in general, people who are genuinely willing to exchange current dollars for dollars which are not valid before 2038. In fact, considering that we have a system in which maturity transformation is ubiquitous, there are probably a lot of financial players who own dollars which are not valid before 2038, but have contracted to deliver valid dollars in, say, March.

We do not actually know where supply and demand would set the 30-year interest rate. It could be anything. If we assume that it has any relation to the present rate, we will, again, create disruption. If we wanted disruption, Plan X would do just fine.

What we see is that Plan Y is essentially a bailout of the entire dollar financial system. The informal guarantees have spread very far and wide. Our goal, in the first (formalization) phase of the plan, is to find them all and use formal dollars to buy them all out at the present market price. One of the largest sets of informal guarantees is the set of promises the US government has made to itself in the form of Medicare and Social Security, which may give you some idea of the kind of numbers we're looking at. (Fortunately, entitlement payments are not securitized and thus are not on the balance sheets of term transformers, which means they can be exchanged for latent dollars.)

When Plan Y(1) is complete, everyone's monthly portfolio statement should show more or less the same number that it did before, and the Fed will enjoy managing many fascinating new assets. F, the final monetary base, will be a precise measure of the number of dollars in the world. And we are free to go through with Plan Y(2), which is precisely the same as Plan X(2): redeeming all dollars for gold.

However, we are no longer increasing the gold price by a factor of 3. The factor is now more like 300. This does not require any more or less secrecy or surprise than increasing it by 3 - in both cases, discipline must be absolute. But it does make us think a little.

Not all the gold in the world is in Fort Knox. If you increase the gold price by two orders of magnitude, you are making anyone who now owns gold extremely wealthy. This happens - people make money, and they make money by being right when everyone else is wrong. Predicting that paper money was unsustainable and the gold standard would live again was not exactly a conformist investment. If you restore the gold standard, you have validated it.

Also, you can tax the hell out of these people. Any restoration of the gold standard should be associated with a high direct tax on gold ownership. If the tax is too high, it will pass the Laffer peak and favor the really crazy antigovernment types who keep their Krugerrands in their flowerpots. 80 or 90%, for example, is probably too high. But 60% probably isn't.

The new gold zillionaires will certainly compete in some markets and drive up some prices, but it is hard to see how they will much inflate the price of, say, crude oil, or wheat. It's also worth noting that a lot of the world's gold, especially the gold that hasn't been mined yet, is in places like India and Africa, which could sure use a little money. And while no increase in the gold price will produce a giant flood of newly mined gold - people have been trying very hard for a very long time to get gold out of the Earth's crust - two orders of magnitude will certainly create a lot of jobs, not all of which are menial. Perhaps some of our financial engineers could go back to school and study geology.

On the other hand: once we have executed Plan Y(1), do we really need Plan Y(2)?

After all, our goal in restoring the gold standard is hard money: a completely neutral monetary system, which is not subject to manias and panics, and does not bollix economic prediction by exerting a chaotic, exogeneous, politically charged effect on price levels or business activity. In other words, our goal is to never have to deal with this kind of BS again. Condy Raguet put it well when he said:

Such being the theory of this branch of my subject, I have the satisfaction to state in regard of the practice under it, upon the testimony of a respectable American merchant, who resided and carried on extensive operations for near twenty years at Gibraltar, where there has never been any but a metallic currency, that he never knew during that whole period, such a thing as a general pressure for money. He has known individuals to fail from incautious speculation, or indiscreet advances, or expensive living; but he never saw a time that money was not readily available, at the ordinary rate of interest, by any merchant in good credit. He assured me, that no such thing as a general rise or fall in the prices of commodities, or property was known there; and that so satisfied were the inhabitants of the advantages they enjoyed from a metallic currency, although attended by the inconvenience of keeping in iron chests, and of counting large sums in Spanish dollars and doubloons, that several attempts to establish a bank there were put down by almost common consent.

This is not the only historical example of the delights of monetary predictability. And there is nothing more predictable than a constant. Suppose that, after formalizing the dollar base, we just leave it at that? Why do we need the gold standard? Can't we just fix the number of dollars in the world, and call it a day?

We can. But we may not want to.

Gold makes a good currency for several reasons. First, because it has some intrinsic uses, it is self-bootstrapping in the classic Mengerian sense. But the dollar is already a currency, so bootstrapping is not a concern. From an economic perspective, fiat currencies work fine. Second, after a few millennia of mining, new gold is extremely hard to come by, so the supply is quite inelastic. (The present gold supply dilutes at well under 2% per year.) Inelastic is almost constant. But constant is even more constant.

So a fixed, formalized dollar supply would create a currency that was actually harder than gold - at least, in a strictly economic sense. The dollar would not be "as good as gold." It would be better. (If only we could do the same for Hillary.)

This course of action would also have the effect, surely delicious in some peoples' minds, of sending the gold price back down into double digits. People who hold gold (such as myself) are, in general, holding it as money. If you fix the fiat currency system permanently, you destroy the entire monetary premium on gold. If this course is taken, perhaps its architects could have some pity on us poor economic royalists, and print a little extra to buy back our Krugerrands.

The only problem with a fixed-supply fiat currency is that it has been tried before. It's one thing to limit the number of dollars in the world. It is quite another to enforce that limit. Congress can pass a law prohibiting the Fed from printing new money. But will it? And next time there is a war, a flood, an indoor rainforest in Iowa, or some other budgetary emergency, won't it just unpass it? Our F might quite easily become like the Federal debt limit, which is routinely increased. A better idea might be to put it in a Constitutional amendment. But even these can be repealed, or still worse judicially ignored.

As Alan Greenspan once explained, gold as a monetary standard succeeds because it is self-enforcing. The Fed cannot print gold. Congress cannot pass a law which creates it. If the gold standard is really brutally abused, as it was in the 1920s and '30s, it will turn on its abusers with a vengeance. This is not a bug, but a feature. Gold works because it keeps the government honest. And surely anyone of any political persuasion can agree that honest government beats the converse.

Of course, the main problem with Plan Y, gold or no gold, is that it can't possibly happen. It is impossible to imagine Washington executing any plan anywhere near this unusual and aggressive. Moreover, the first step is always to admit that you have a problem. Picture that press conference! I can't, which is why I can't see this happening.

47 Comments:

I am scared to death since years about the coming financial crisis, and I also thought about converting some money to gold.

However, with gold there are very big problems. How do you solve them?

First, I can't in any way decide if "gold" is really gold, I need to trust whoever I am buying that from. This implicitly means that I can buy just at a much higher rate than I can sell.

Second, gold looses weight too fast. I mean, it is absolutely insecure keeping it at home. And if I need to pay for safekeeping it, that effectively means it looses weight :). And the economy of scale is against me in this case, as I can buy not too big of a quantity.

I can keep a "gold account" at a bank. Now what on earth tells me that if comes the next great depression, I can go to the bank, there will actually be anybody to open the door, and wouldn't tell me that they are sorry, my gold is gone?

Interesting enough, I just learned that my country (Hungary) found the costs of safekeeping gold so high that they stopped doing it: they just opened a "gold account" in some swiss bank... Wow.

I think you nailed it Seamus. The owners of this land can establish the currency as whatever they want it to be and back it with whatever they want to back it with - or nothing at all. Their interest in doing so is simply to keep the plainlanders productive and pacified. Whatever works best for that objective is what they want to do, and what they will do. There's also the matter of what works best in the short term versus the long term, and the the owners are only interested in the short term.

baldvin, if you've got access to world markets you can buy securities that proxy gold almost directly, most particulary 'streetTRACKS Gold Shares ETF' (NYSE: GLD). There are overhead costs, but they are pretty low, and of course if gold does get remonetized the low overhead will be swamped by the huge value increase.

It's true that with a sufficiently severe financial crisis, you might not be able to redeem your investment. But then, there's risk in any direction.

If you think such a crisis is at all possible, then you had better be buying physical gold. This in spite of it "losing weight", by which I assume you mean value. You can store quite a lot of it in a bank's safety deposit box, if you think that you'll at least be able to get into the bank. Or, you can buy it and bury it somewhere at home. Build it into a wall or something -- there's lots of ways to hide stuff that nobody but an insider is going to find.

Me, I don't own any physical gold. I believe that the signs of impending hyperinflation will be reasonably clear, and it's not happening any time soon. Of course, if I did own physical gold... I might not admit to it. That's the key to gold, right there: you can really, truly, hide it.

I've been using digital gold currency for years now. Its simple to buy and use online. I know what is behind every spend I make, 100% pure gold bullion. The accounts are denominated in grams not dollars so there is some additional understanding of how the account operates. However, this is much different than using gold coins as money or 100% backing paper money with gold. That, would be impossible in today's world, but as Ron Paul says, allow gold and silver to circulate along with dollars.....give people the choice now there is a real solution.MarkDGCmagazine

Moldbug, you've got a good mind. I suppose it is interesting to play with abstract ideas like "how would a well-run state return to a gold standard", or just "how would a well-run state do money" (answer: fixed supply, as you indicate at the end of the piece). But this is rather like appying your powerful brain to the problem of how Superman could catch a falling Lois Lane at the last second without crushing her. Once you've smuggled in a far-out counterfactual, further work serves only to demonstrate what a smart guy you are.

Now, let me posit the following idea: that 100 years from now, even 50, it's pretty unlikely that the dollar will have maintained its current trajectory through quantity-space. Historically, the dollar is being inflated at some 4.8% per year -- something like that. (That's what I compute for M1 since 1959, using the Fed's data.) So, using that we might predict that in 50 years, M1 will be roughly 10x its current quantity.

But that's what I guess will not be the case, because in between now and then, the US will have either hyperinflated, or else just "kiloinflated" -- meaning a large inflation rate but not in the hyper range. It's likely that the dollar will still exist, but there'll be more zeros on our bills. But it seems possible, at least, that gold will be remonetized if the crisis is bad enough.

So, how about you start thinking about some more likely paths to gold remonetization? I'm curious to see what you think.

Seamus, you really need to Rothbard's article, "The Mystery of Banking". http://www.mises.org/mysteryofbanking/mysteryofbanking.pdfRothbard lays out what makes good money in the third section, page 10: Amid this variety of moneys, it is possible to analyze the qualifies which led the market to choose that particular commodity as money. In the first place, individuals do not pick the medium of exchange out of thin air. They will overcome the double coincidence of wants of barter by picking a commodity which is already in widespread use for its own sake. In short, they will pick a commodity in heavy demand, which shoemakers and others will be likely to accept in exchange from the very start of the money-choosing process. Second, they will pick a commodity which is highly divisible, so that small chunks of other goods can be bought, and size of purchases can be flexible. For this they need a commodity which technologically does not lose its quotal value when divided into small pieces. For that reason a house or a tractor, being highly indivisible, is not likelyto be chosen as money, whereas butter, for example, is highly divisible and at least scores heavily as a moneyfor this particular quality.

Demand and divisibility are not the only criteria. It is also important for people to be able to carry the money commodity around in order to facilitate purchases. To be easily portable, then, a commodity must have high value per unit weight. To have high value per unit weight, however, requires a good which is not only in great demand but also relatively scarce, since an intense demand combined with a relatively scarce supply will yield a high price, or high value per unit weight.

Finally, the money commodity should be highly durable, so that it can serve as a store of value for a long time. The holder of money should not only be assured of being able to purchase other products right now, but also indefinitely into the future. Therefore, butter, fish, eggs, and so on fail on the question of durability.

You can easily read the entire article in 30 minutes, and I guarantee you it will expand your mind if you haven't.

I agree that gold, or some other commodity of which there is a supply not manipulable by government, would be a better basis for a currency of stable value than we have today. However, history shows that even specie standards have been repeatedly manipulated by states. Inflation happens because it is in the interest of the state (as defined by the politicians in charge of it).

The original currency of the Roman republic was the as, a copper bar weighing one Roman pound (12 oz.) The difference between this Roman pound and the present pound troy is negligible enough that for practical purposes they may be considered the same. The as was reduced from 12 oz. to 4 oz. in about 268 BC after the war with Pyrrhus, again to 2 oz. in 242 BC at the end of the first Punic war, to 1 oz. in 217 BC at the beginning of the second Punic war, and in 89 BC to 1/2 oz. during the Social war. The Lex Valeria of 86 BC allowed debtors to take advantage of the last devaluation in that they only had to pay 1/4 of their debts.

The devaluation of the as led to the introduction of a new unit of currency, the sesterce, worth 2-1/2 (semis tertius) asses. It is in sesterces that we find most ordinary transactions expressed during the time of the late republic and early principate. Four sesterces made a denarius. By the time of the Antonines (I have in my collection a denarius of Antoninus Pius) the denarius was a silver coin a little bigger than a modern dime.

These monetary units had a long survival, their descendants circulating in most of medieaval Europe. The denarius became the English penny and as such was debased on numerous occasions. Finally it became impossible to maintain it as a silver coin at all. Copper halfpennies were introduced tempore Elizabeth I and the 'cartwheel' penny that circulated in Britain until the late nineteen-sixties was introduced temp. George III. The sesterce, of course, was represented by the farthing, a coin about the size of the present U.S. cent. If one considers what 40% of an old copper U.S. cent (they are now copper-washed zinc) would be worth, one has the current value of the Roman as after 2,300 years of inflation!

England preserved the value of the old Roman units of coinage better than did most of the nations on the Continent. Twelve denarii made a solidus (shilling). The British shilling was a silver (later cupro-nickel) coin about the diameter of a quarter, and a little thicker. In France the solidus became a billon, later a copper coin of very low value - the sou. Twenty of these made up the livre, which by the time of the French revolution was a coin about the size of the 19th and early 20th-c. silver franc. So, when one says "I haven't a sou" one is very poor indeed.

It is certainly more difficult to trick the citizenry by debasing the metal of coinage or reducing its size than it is by, say, cutting the discount rate by 75 basis points. Nonetheless, people wise up sooner or later. I recall touring through Argentina and Brazil in the early 1980s, when both those countries were experiencing severe inflation, the effects of which were palpable from week to week. Every hotel or retail store had a little exchange window at which foreign tourists could get a supply of the local shinplasters. The operators of these places were, I suspect, rather sophisticated arbitrageurs. If one presented a traveller's cheque rather than American or European currency, they would always ask that it not be dated. They'd fill in the date a week or two later, I suspect, and get more of the local currency than they could have done had they cashed it immediately.

I do not think that fractional-reserve banking (in "blue dollars") is possible to eliminate. It grew up outside the state, even before the Medicis started broking pawn, and will continue outside the state, because banks are not the only sources of credit. As long as there is credit, there will be monies of account and some sort of bills of exchange, even if all these are are the little chits one used to get from the manifold books of grocers and druggists when buying on open account from them as one did when I was a boy.

The way to have sound money is rather to manage fractional reserve banking properly under a gold standard, as (for example) it was done by the Bank of England from about the end of the Napoleonic Wars to the beginning of World War I. During that approximately century-long period, the pound was very stable and price levels fluctuated very little. It is worth noting that during this period the Bank of England was privately owned (mostly by the Cavendishes, the family of the dukes of Devonshire). The most drastic inflation of the pound took place subsequent to its nationalization in 1946 under the Attlee-Cripps Labour government, illustrating my initial point that inflation takes place because politicians think it is in the state's (or their own) interest.

I do not think that fractional-reserve banking (in "blue dollars") is possible to eliminate. It grew up outside the state... and will continue outside the state, because banks are not the only sources of credit.We cannot utterly eliminate it, but then we also cannot utterly eliminate other species of fraud, for example, ponzi schemes. Nonetheless, we make them illegal, and we reduce their incidence drastically. How many large corporations (other than Washcorp, that is), are running ponzi schemes?

Ironically, your gold standard plan would cause temporary hyperinflation as the higher gold price brings gold from around the world into the US money supply.

To avoid it, you would have to do something like: publicize the plan, then set Pnew at the new Pold, then acquire enough gold to cover the full monetary supply if you want a 100% gold standard (better to purchase gold beforehand, but in the end it would be hard to avoid mostly paying the higher price).

Basically, any time you replace a fiat currency with a 100% hard currency, someone has to pay up 100% of the value of the money supply to acquire the assets to back it. What isn't paid by the government is going to have to be paid by currency holders.

The point is, of course, not that any of this is possible, probable, or even likely.

The point is (to use UR phraseology) how one convinces the BDH/OV that it is in their best interest to reconvert their money into something apart from federal reserve dollars.

It was difficult enough to being the Fed in the first place -- and would be impossible in today's information climate.

One would assume that the OV faction would be the easiest and first to convert -- the Vs especially as they, being the reasonable, hardworking sort, don't like much the idea of inflation. Then possibly the HDs -- as they aspire at some point to become Vs (or at least like the Vs.

The Bs, however, present a little more of a challenge. Inflation, after all, benefits any debt-holder. Brahmins, by their very educational aspect, are likely to hold debt for college if nothing else (though they are just as likely to hold mortgages).

The Os, of course, won't matter much -- as they have all the money, accountants, and lawyers that they need to ride such a wave.

Noting these points we must ask -- how do we convert the volk into people who care about what sort of money they have?

To Leonard - do you consider trade upon private credit, and private bills of exchange, to be frauds on the order of Ponzi schemes? I should rather say that they are ordinary business practises that have a history, in the European countries, dating back at least to the thirteenth century. They are too deeply ingrained in our way of life and too useful to be abandoned. Besides, they are not responsible for inflation and its numerous evil consequences. Inflation is a creature of the state.

do you consider trade upon private credit, and private bills of exchange, to be frauds on the order of Ponzi schemes?

No. But then I don't consider fractional reserve to be as fraudulent as a Ponzi scheme either. I was not meaning to compare the two for degree of fraudulence, but rather, the effect of being legal or illegal.

Note that it is quite possible to run a bank now without considering what you are doing as fraudulent, even though you know exactly how it works. Not so with a Ponzi scheme, or at least you have to invent a really "good" scheme to self-delude to that degree. This difference, alone, makes the one "more" fraudulent: it's almost impossible to do it without willful intent to defraud. Note that the law helps to signal this; its effect is achieved not merely by scaring off potential Ponzis by threatening them.

Note that I do consider the knowing use of "unbacked" credit to be fraudulent. This goes for any possible implementation: private credit lines, checks, or banknotes.

As you say, a bank account is essentially a loan from yourself to the bank. It is not possible to have a loan with which the lender can demand immediate repayment of his loan whenever he feels like it, because the borrower doesn't have the money on hand, he's using it for something, otherwise he wouldn't have borrowed the money in the first place. But there's always some default risk associated with making loans, and even if a bank isn't lending out the money in your account but is only holding it and transferring it for you (in which case it is not paying interest but is charging fees) there still is, if nothing else, the risk of robbery. The point is, gold standard or no, there is no such thing as a 100% safe bank account. Certain kinds of financial shenanigans would be harder to get away with with a gold standard, but I don't see why term-shifting would cease to exist. It would be clearer that there is a risk that one's money may be unavailable when one wishes it, but people might well be willing to tolerate that risk if it was considered sufficiently small and the rewards were sufficiently great.

It seems to me that the major problem associated with term-shifting is a result of the fact that the chance of a bank being unable to meet its obligations is not an independent event, but rather that, because of the way banks lend to each other, you can quickly go from a situation in which everything seems to be ducky to a one in which no banks have any cash on hand and they're all facing demands from depositors. But this seems to be a problem intrinsic to demand deposits, and to have nothing to do with the gold standard as such.

Congress can't pass a law creating new gold, but it can pass a law saying that the treasury will give you half as much gold for your dollar as you got yesterday. I fail to see how a gold standard is in any way self enforcing. Of course a numbered dollar supply isn't self enforcing either, but it has the virtue of simplicity.

They may have similar or the same end results (your money is worthless or worth less, you know, depending) but they aren't the same for a very simple reason:

devaluation is "done by the government"andinflation is "done by the market."

Now, it may be true that government policy allows inflation to happen and even (*cough*Bernanke*cough*) can encourage it -- BUT (and it's a big, Nemo-like but) inflation gives the gubmint the way "out."

"It's not our fault -- we don't run the market -- it's the market that creates inflation."

This line of reasoning does something that direct devaluation cannot possibly do --reduce the number of angry, pitchfork wielding citizens.

The gold standard, therefore, is Good because it protects against inflation. No seriously well-managed government will ever use devaluation willy-nilly because it would turn their well-trimmed citizen hedges into vicious thorn-bushes of rage. Gumbint, therefore, cannot rely on the elimination of debt through the depreciation of money (or the expansion of m3, if you will) and must act accordingly.

I could imagine a gubmint (sovcorp) splitting its money if it were to become too valuable -- that is if the penny all of a sudden could buy a gallon of gas. We'd need a smaller unit. But even then devaluation would be ordered and regular -- not a radical restating of the value of gold.

Accidents are quite frequent in life and on numerous occasions they lead to some sort of distortion in some body parts. In the past, such incidences had no treatment at all and the person had to live with that scar forever. The scenario has changed a lot and with the advancement in the medical science these abnormalities in shapes of certain body parts are treated artistically. Cosmetic surgery has come to the rescue of those for whom beauty has been enticing. From ancient times, women had fantasized of looking beautiful and so is their wish in the modern era.To find about cosmetic surgery loans, bad credit cosmetic surgery loans, easy cosmetic surgery loans visit http://www.easycosmeticsurgeryloans.co.uk

G.M. Palmer, I fail to see how the debasement of a metallic currency differs functionally from inflation.

Few debasements were formal devaluations like that of the Roman as (which in retrospect was probably a poor example to have used as an illustration) or like FDR's revaluation of the price of an ounce of gold from $20.67 to $35. They were, rather, surreptitious reductions in the amount of precious metal in a coin, the reduction being made up with base metal to produce coins that bore superficial resemblance to the old ones. The usual motive was to permit the sovereign entity to pay off its debts in cheaper money than that in which it contracted them. Both the motive and the outcome differed in no important regard from the printing of more and more assignats, reichsmarks, or dollar bills that became fashionable techniques at a later period. When a sovereign power monopolizes the issuance of money within its realm, under normal circumstances inflation can only be created by the act of the sovereign.

About the only real market-driven inflation of which I can think at the moment was, oddly enough, connected with the gold standard. It happened in 16th-17th-c. Spain, as a consequence of being flooded with an immense new supply of gold from the New World. One of the normal advantages of gold as a basis for currency is that there is a fixed supply of it. In early modern Spain, that assumption was not true, and the great influx of new gold debauched its economy severely in a classic illustration of too much money chasing too few goods.

One of the historical phenomena that has long fascinated me is the craze for chrysopoietic alchemy in the German principalities, which peaked between the sixteenth and the eighteenth centuries. Most of the princelings forbade the practise of alchemy to their subjects, yet were avid employers of alchemists themselves. Why? Because they were quite conscious of the inflation that the introduction of more gold into their domestic economies would have, and they wanted to be in control of the process.

Alchemy and mercantilist economics have historically documented links in the history of the Holy Roman Empire. J.J. Becher, alchemist to the court of the emperor Leopold I, put forward the topsy-turvy phlogiston theory of combustion, and was also a pioneer of mercantilism. A founding treatise of mercantilism, the "Fürstliche Schatz- u. Rent-kammer", was written by the baron von Schröder who was subordinate to Becher in the court's organizational chart.

Obviously we cannot make gold cost-effectively (it has been done in cyclotrons at the microgram level). Once this truth sank in to the minds of rulers and politicians, they turned to the printing press and central banking. Their motives and objectives have remained the same.

Mr. Palmer, I think you are making a distinction where there is no difference.

A _surreptitious_ debasement of currency by reducing its precious metal content and an inflation of paper money by printing more are neither of them openly proclaimed to the public in the manner of the type of devaluation you describe. The market figures out that debasement has occurred, sooner or later. but the market is not the causative agency of the inflation in either event. The sovereign - the issuer of the monetary units - is.

A thought-provoking post. As I have probably mentioned before on RGE, my concern about a gold standard would be what might happen if the supply of gold was suddenly significantly expanded by some technological breakthrough. Gold may have been in limited supply historically, but technical progress has accelerated. For the same reason, I would be wary of holding a large proportion of my wealth in gold. Pegging a currency against a basket of commodities would reduce the impact of such developments, and might also allow a reduced price jump as the commodity standard is introduced.

Rebel Economist:Have no such fears. Do you believe it more likely that a sudden technological advance will make gold cheaper than paper?When the Spaniards invaded the new world, they found much gold and silver which they brought back to Europe which gave rise to "inflation" in Europe. When the Alaska and South African gold strikes came through in the 1890s, the world saw some gold inflation. Don't worry about it. Gold is more stable than paper.

Rebel, I gotta ditto that last guy. Right now you might possibly be able to synthesize gold, via neutron bombardment... but even with pretty cheap energy (6 cents per kilowatt hour), that would require something like $1800/ounce, just for the energy. Then you add inefficiency in various parts of the process, and the costs of the base materials (mercury is not that cheap), of building massive particle accelerators, of disposing of all the radioactive crap you generate incidentally... and then the price of energy goes up. I doubt it will be possible to synthesize gold via transmutation of elements at less than maybe $5000 per ounce. Something like that. So there's still plenty of upside before our currently available tech can add to supply.

So what other possible sources are there? One is asteroid mining in space... but access to it is still extremely limited, and it's pretty valueless. Nobody is going to be prospecting for gold asteroids in the next 100 years. Just getting anything into low earth orbit is still $10000/pound. That is, just putting something in orbit makes it costlier than gold.

Possible new gold strikes? Well... maybe... but we've covered most of the world pretty well by now, prospecting. Maybe there's gold under the antarctic ice cap or something. It won't be cheap to get to.

The ocean? There's a hell of a lot of gold in seawater, at extremely low concentrations. In theory someone might figure out how to extract it, but again we're talking a huge energy cost.

Maybe we were better off on the gold standard. But despite how much dilution has occurred, things still seem pretty good. I think fiat will endure and continue to stay a non-issue.

The idea that monetary policy can be managed by mathematical models is, in fact, madness. The experiment is neither deductively understood nor scientifically controlled. Fitting models to the past is no substitute: it will always produce a "data mining" effect. If one of these models somehow turned out to be correct, you would have no way of knowing which one it was.I thought it was more the result of politicians yelling at the Fed to DO SOMETHING. What would you think of a system run by a computer with a constant low rate of inflation as a linear function of GDP?

In this article Gary North claims the Gold Standard of 1815-1940 was a "gigantic fraud". He also claims Ludwig von Mises supported free banking rather than 100% reserves. I guess Selgin & White really are Misesians! What is your issue with free banking again?

The only problem with a fixed-supply fiat currency is that it has been tried before. It's one thing to limit the number of dollars in the world. It is quite another to enforce that limit. Congress can pass a law prohibiting the Fed from printing new money. But will it? And next time there is a war, a flood, an indoor rainforest in Iowa, or some other budgetary emergency, won't it just unpass it? Our F might quite easily become like the Federal debt limit, which is routinely increased. A better idea might be to put it in a Constitutional amendment. But even these can be repealed, or still worse judicially ignored.That seems to be the point Gary North made about the gold standard as it was actually implemented in history.

If the gold standard is really brutally abused, as it was in the 1920s and '30s, it will turn on its abusers with a vengeance. This is not a bug, but a feature. Gold works because it keeps the government honest. And surely anyone of any political persuasion can agree that honest government beats the converse.How is that different from fixed-fiat currency? And wasn't the result of the 20's and 30's the New Deal and confiscation of gold? That's hardly a positive result of abuse and a maintenace of honesty!

G.M. Palmer:Then possibly the HDs -- as they aspire at some point to become Vs (or at least like the Vs.I think many don't aspire to at all. Given that a great many will not, that would be realistic of them.

The Bs, however, present a little more of a challenge. Inflation, after all, benefits any debt-holder. Brahmins, by their very educational aspect, are likely to hold debt for college if nothing else (though they are just as likely to hold mortgages).Initially they may have college debt, but afterward they are likely to be fairly well off. They are considerably less likely to abuse their credit cards than Vaisyas, for example. It is the government that is the biggest debtor and who therefore have the greatest interest in inflating. Since inflation does not spread evenly, it can be surmised that those who get it first will also want it. This could include government contractors or Wall Street more generally.

It has been surmised that because people are relatively over-sensitive to nominal wages than real ones, inflation is helpful in acting against the sticky downward rigidity of wages. Bryan Caplan discusses that here. Inflation can help counteract the effects of the minimum wage and government supported labor unions.

Please remove the post of that James Carig, ban him, mark it as spam or whatever.

Leonard:I know some chemists and physicists. We discussed various ways to extract gold from things. Getting gold from sea water would run $5,000 per ounce. Easily. Maybe triple that. You can't readily make gold. That's one reason: GOLD IS MONEY!

Leonard:I know some chemists and physicists. We discussed various ways to extract gold from things. Getting gold from sea water would run $5,000 per ounce. Easily. Maybe triple that. You can't readily make gold. That's one reason: GOLD IS MONEY!

Mencius,Let me start by saying I like the idea of a gold standard as a way of controlling the issue of currency by government and imposing at least some discipline on the other players in the economy. The outcomes of the standard are also difficult to argue with - the periods when the US and other currencies were on the gold standard and / or practising free banking were impressive. The growth in the US economy that underpins the current strength during the period from the Civil War to WWI is undeniable.This discipline though, comes at a considerable cost - the costs to either purchase or mine and then store and secure the gold. If, as you say, the monetary base is USD800bn, then that is (at least) USD800bn in gold that is needed to fully back the currency (unless you allow "fractional reserve currency" :) ). The opportunity cost of holding that much gold is huge - even at 5% interest it is USD40bn a year. Granted, not as much as a small war in the Middle East, but a fair amount.Additionally, once a substantial proportion of the world adopted the gold standard, as would be likely, the relative scarcity of gold would mean that the price would increase even further, as would the costs of holding.I would tend to agree with tggp above, where he believes that fiat will remain the standard. I would also strongly encourage a good reading of Hayek or Mises on the subject. I have to deal a lot with banks and they were the academics that I feel best understood what actually happens out there.

I almost hate to throw another variable into the already complex equation, but I tried to do a little research a while back when the price of gold went down from about $400/ounce to about $250 and stayed there for quite a while. I assumed it was being somehow manipulated to prop up the dollar (that's right, I am a conspiracy buff). I got nowhere, though because somewhere (circa 1995?) some countries {cough, Israel, cough} stopped reporting their reserves AND something called gold leasing began, or at least began to be reported.

In my admittedly very dim understanding of leasing, it is a tool that is used by governments to count as reserves gold that it does not actually hold. Whether it is physically in some other place or gone to the private sector, I can only speculate. I'll spare you my half-baked theories, but it is interesting to note that European reported holdings have decreased substantially while only those of Spain(!), Russia and Kazakhstan have increased. I'm thinking that the net decrease in reported holding could account for the temporary lowering in the dollar price of gold (greater supply leading to lower price leading to increased demand and higher price on the private market). All I can show for it is a well-scratched head. Perhaps someone with more intellectual horsepower... MM?

It's also interesting that there is no wiki entry for gold leasing. Spooky. And why did they cancel "The Lone Gunmen" just when it started to get good?

You might be interested in the information in this film (it used to be on google video, I downloaded it so I have a copy but you should still be able to get it from somewhere, even if you have to order it). However it does not endorse the gold standard (it in fact dorses it). I'd be interested to see your views on what it has to say. (although it is over 3 hours long).

Ah, money Changes Everything! The Gold Standard is probably the Most Misunderstood of All Economic Ideas - so you are in Good Company Mencius in being able to miss the Real Reason people ask for Hard Currency...

The Trust in the Government or perhaps the Lack of Trust has resulted in people beginning to suspect their Nest Eggs are made from scrap paper like a cheap discount Easter Basket! The Gold Standard is not what these people Really Want - no they want a currency that still has a similar value when they are too Old to Work!

Students of History like myself know that Paper Money was brought to Europe by Marco Polo in the form of Bank Notes from the Kublai Khan whose Empire was so vast that the physical task of moving tons of Gold across most of Asia, along with the thieves, made it necessary to invent a system of currency that was light and easily transportable. Each note represented a certain amount in weight of precious metal which ensured that it was acceptable everywhere that used Gold or Silver as monies in that the note could be redeemed by the Great Khan in actual physical form...

Obviously, this also led to forgery and counterfeiting which meant Death by Torture if they were caught. Even so, the obvious benefit to the Rich and their agents in not having to transport sometimes tons of metals across long voyages requiring huge trains of bearers and guards made this concept valuable to us today...

The ability to store Gold and Precious Metal in a secure location and still use it to exchange goods was probably the primary reason that commerce is so common today. Unfortunately, the use of Bank Notes instead of hard currencies requires that you TRUST the issuer to Actually Have the Stuff stored somewhere and that he is not an Insane Idiot who thinks he's the Emperor of the United States or Napoleon living today!

The term Bank and Trust is based on the necessity to regard the character of the issuer of Bank Notes as to their actual worth. Until Ulysses S. Grant's presidency, every Bank or State or sometimes even Companies had the ability to issue Bank Notes as long as they were able to redeem them for hard currency...

When the Greenback was issued, the U.S. Government outlawed issues of Bank Notes without the consent of the Federal Government with the assurance that the U.S. Government would back every note with Gold Bullion. Then, later they followed Britain and issued a claim that the notes were backed by Silver - the so-called Silver Certificate Dollar...

However, as people were lulled into the Delusion of the Great Society with Social Security, the Federal Reserve quietly decided to no longer pretend to be able to redeem these scrips with ANYTHING! The Compliant Corporate Media said little about this, as Rich Men suddenly acquired an interest in Numismatism and their Wives suddenly became avid collectors of Jewelry!

Today, the Dollar has No Value, but worry not as the masses be Stupid and will gladly accept the Dead Presidential Portraits as if they were made from Gold! The Federal Reserve has been really emboldened by the fact that its' members are not Hanging from Trees and Lampposts, and now they No Longer Even Bother to print Most of the Stuff!

Most Bankers know that almost All the Dollars in Circulation are imaginary (like their value) and that the bulk of transactions are merely numbers on ledgers! This is why they can issue Credit which Far Exceeds their Deposits and hope No One ever comes to get any physically existing Dollars - cause they don't have much of those! OOPS!

What is the True Value of the Dollar? Don't ask the Fed cause they'll give you the wrong number! The True Value is $0.00 !

One minor factual error: The Nazis called their propaganda efforts not only 'Aufklärung' but 'Volksaufklärung' , roughly translatable as 'Enlightment for the people'. This has a special grandiose and paternalistic tone in german.

As you probably know there existed a governmental department for 'Volksaufklärung und Propaganda', led by the infamous Goebbels.